Truth in Lending

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Truth in Lending (TIL)

The federal law that specifies the information that must be provided to borrowers on different types of loans. Also, the form used to disclose this information.

Truth in Lending (TIL) is a great idea, in principle. The idea is to require lenders to provide one uniform set of price disclosures that are consistent from loan to loan and from lender to lender. Then consumers can make apples-to-apples price comparisons across loan types and across lenders.

The idea has worked concerning the methodology used to calculate interest cost. Borrowers no longer have to contend with noncomparable ways to calculate interest: discount rates, add-on rates, and internal rates of return. The last has become the standard; see Mortgage Formulas.

Unfortunately, in all other respects, TIL as it has been applied to mortgages is a disaster.

APR: The internal rate of return used to measure interest cost on a mortgage is called the annual percentage rate, or APR. The APR on a mortgage is misleading because upfront fees are a major cost, yet only some of them are included in the APR. In addition, the APR assumes all loans run to term, when in fact most mortgages are paid in full well before term. See Annual Percentage Rate.

Useless Information: The TIL also includes useless information that distracts borrowers and causes confusion.

Total payments: This is the monthly payment multiplied by the term.

Amount financed: This is the loan amount less “prepaid finance charges,” which are the selected upfront charges that are included in the calculation of the APR. If the loan is $100,000 and fees are $3,000, the amount financed is $97,000.

Finance charge: This is the sum of all interest payments over the term of the loan, plus the prepaid finance charges.

All these numbers are totally useless for comparing loans of different type or for shopping different loan providers.

Notice of Prepayment Penalty: This is hopelessly confusing, worse than no disclosure at all. See Prepayment Penalty/Surreptitious Penalties.

What Isn't Disclosed That Should Be: In addition to making the prepayment disclosure comprehensible to borrowers, the TIL should replace the useless information listed above with information that is critically important to borrowers.

Total Lender Fees: In addition to points, which are an upfront charge expressed as a percent of the loan, lenders also charge a variety of fees that are expressed in dollars that do not change with the size of the loan. These fees are disclosed on the TIL only indirectly. Subtracting the “amount financed” from the loan amount will yield the fees. If one borrower in 100 knows enough to do this, I would be surprised. (Note: The Good Faith Estimate (GFE) shows individual lender fees but mixes them with third-party charges, provides no total, and does not commit the lender, since the numbers are “estimates”.)

The TIL should also commit the lender to these fees. When borrowers “lock” the price of a loan, the lender is committed to the rate and points but not to fees, paving the way for larceny at the closing table. The Federal Reserve, which administers TIL, could easily prevent this by requiring that all locks apply to the APR, which is calculated from the rate and all lender fees.

Margin on ARMs: The margin on an ARM is the lender's markup—the amount the lender adds to the interest rate index on a rate adjustment date to obtain the new interest rate. It can be 1.5%; it can also be 6.5%.

Lenders always quote the initial rate on an ARM but they seldom quote the margin, and it is not a required disclosure. On an increasing number of ARMs, the initial rate holds only for one to three months. (This includes all flexible payment or option ARMs and all home equity lines.) On these loans, the borrower knows the interest rate for the first few months, but often doesn't know the lender's markup over the remaining 29 plus years. It should be a required disclosure.

Is the Loan Simple Interest? On simple interest loans, interest accrues daily instead of monthly, imposing a stiff penalty on borrowers who pay past the due date. See Amortlzation/Amortization on a Simple Interest Mortgage. Most borrowers who write me about their problems with simple interest loans never knew they had one until the problems emerged. TIL should require lenders to disclose it.

Subordination Policy on Second Mortgages: Very few borrowers who take out a second mortgage are aware that the second mortgage lender can prevent them from refinancing their first mortgage. When the existing first mortgage is repaid, the existing second mortgage automatically becomes the first mortgage unless the second mortgage lender is willing to subordinate his claim to that of the lender providing the new mortgage into which the borrower is refinancing. See Second Mortgage/Subordination by Second Mortgage Lender.

Policies of second mortgage lenders regarding subordination vary all over the lot, from a small fee and no conditions to absolute prohibition. Borrowers taking a second mortgage should see the lender's subordination policy on the TIL.

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